ECB’s Negative Deposit Rates – Busting the misinformation

After yesterday’s ECB decision to venture into negative deposit rate territory; which now the mainstream media terms it as ‘Historic‘ there have been many articles cropping up about how the ECB’s negative deposit rate will affect the retail consumers. Part of this hype can be related to misinformed writers who have no clue on how the money system works in today’s economy (which hasn’t really changed since the past few decades). This article’s aim is to provide a fact based analysis of the effects of negative deposit rates and thus concludes that for the average retail customer who banks with the high street banks, there is nothing to worry about, let alone panic.

Negative Deposit Rates – For What and for Who?

Large commercial banks and financial institutions such as HSBC, Deutsche Bank and the likes need to have an account with the ECB (European Central Bank) in order to operate. The ECB, being the Central bank has the responsibility of being the ‘lender of last resort’. In other words, if things get really bad, the ECB can step in to calm the money markets. The ECB (and Central banks across the world) are the only legal entities recognized by their respective sovereign governments that are allowed to print money at their will (with the threat of inflation and currency devaluation). It is this very basic feature of the Central Banks, that give it the term ‘lender of last resort’

The Central Banking System

Just the way large companies have corporate accounts with their high street banks, so do the commercial banks with the ECB. The ECB’s banking system coordinates the money supply between their customers (the commercial or high street banks). This system ensures that the banks use the ECB’s system to settle daily payments.

Take for example Mike who banks with Deutsche Bank just sold his spare real estate property to John who banks with HSBC. John would pay Mike, which means that HSBC has to pay Deutsche Bank. This basic payment is settled with the help of the ECB’s payment system.

Reserve Requirements Ratio

When it comes to banks and bank deposits, one might have come across a terminology called the ‘Reserve Requirements Ratio’. This fancy jargon is nothing but a requirement for banks to have a certain amount in cash parked at the ECB in relation to their total amount of depositors.

For example, if ACME Bank has a total customer deposit value of $100,000; ACME Bank must keep $20,000 in cash with their Central bank, which they cannot touch and can be used only in times of extreme crisis (beyond the point where ACME Bank cannot borrow money from other banks).

Money Supply – Electronic and Physical

Within the scope of a monetary system there are different kinds of money in supply at all times. The money system used between Banks and the Central Bank is purely electronic (numbers entered into the assets and liabilities of the respective bank’s balance sheets). The money system used between Banks and its (retail) customers is physical. The bank therefore is the intermediary and thus converts the electronic money into physical money to be used by its customers.

Negative Deposit Rates are for Banks that have excess cash with the ECB

The negative deposit rate that the ECB launched is therefore purely within the confines of the money between the Banks and the ECB. The reason the ECB decided to charge its customers, the commercial/retail banks is to ensure that except for the minimum reserve requirement, excess cash parked with the ECB should be used by these banks to flood the economy (in an effort to ease lending conditions to boost growth, which is what QE is all about).

Why negative deposit rates?

The reason why the ECB embarked on negative deposit rates is to help kickstart lending in the Eurozone. Banks make money by lending and the interest payments on these loans is what makes the bank money in simplest terms.

To misunderstand the ECB’s negative deposit rates as banks charging the average John Doe money to park his deposit at his High Street bank is ludicrous at the very least.

With the help of Negative deposit rate of -0.10%, the ECB hopes to flush out excess cash held by banks, which until now was at 0%.

In other words, the money was sitting with the ECB doing nothing. The reason behind this can be attributed to many factors. Stagnating growth in the Eurozone, threat of deflation and not to forget, the ‘still fresh’ Greece bond crisis that shook up many a big banks in Europe. Given the circumstances, banks found it safer to park their cash with the ECB rather than risk another bond crisis.

Putting it all together

How Negative Deposit Rate Works
How Negative Deposit Rate Works

To conclude, let’s take another example.

What would you do with a few bars of Gold? Most likely answer is that you would store the bullion in a bank for safekeeping. When you deposit your Gold with the bank, does the bank pay you interest? Unlikely.. rather you end up paying extra fees for safekeeping of your bullion. The bank cannot risk liquidating your Gold (selling it for currency) and try to make a profit on it. Comparatively, its easy to see understand why banks will never afford to charge you, their customer interest for keeping your money with them, when in reality banks tend to treat you with a smile when you park more money with them.

While the ECB’s decision is definitely a new thing among the developed economies, the basic purpose is to get rid of the money at the Central bank and move it into the economy. Central banks that have engaged in QE (US, UK, Japan, China) have often faced one common hurdle… which is, to get the money out into the economy. Most often banks that get more cash with discounted interest tend to use that money to directly invest in higher yielding assets such as stocks rather than risk giving away most of it as loans (mortgage, study loans, business loans, etc).

The negative deposit rate, might be a new terminology for the average retail customer and its easy to get it confused with your deposits, but it definitely does not affect the way you bank. For now, rest assured that the negative deposit rate affects just the banks and is between your high street bank and the ECB.

About the author: Editorial Team

ForexPromos Editorial Team is comprised of a selection of hand picked editors that bring you the latest breaking news from the financial markets. We also provide forex educative articles as well as comprehensive fx broker reviews.

Related Posts